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Making ownership pay

Fair compensation is the foundation of a good partnership, but it's not an easy thing to arrive at. Some practice owners decide on a salary arbitrarily, while others do what I call "bottom feeding"—cutting themselves a check for whatever is left over at the end of the month. Neither approach is fiscally responsible, even for a sole proprietor. Applying these methods to a partnership just compounds the confusion. If you're an owner, how do you know if you're getting paid fairly?

One compensation formula I've written about in the past is ProSal. With this approach, doctors are paid based on a percentage of their production but receive a guaranteed base salary. ProSal works well for associate doctors, but it doesn't provide for a return on investment or division of net profit for partners. In addition, ProSal may not adequately account for disparities in time, ownership, and management responsibilities.

Fortunately, there's a compensation method that allows for these differences within partnerships. It's called the Four Tier formula, and it's designed to provide fair compensation to owners on the basis of their individual production, stock ownership (and therefore return on investment), net profit, and management time. Let's look at each of these tiers.

TIER 1 PRODUCTION

For the first tier of the Four Tier formula, the practice pays each owner a percentage of his or her production. This percentage normally ranges from 18 percent to 25 percent, depending on what benefits the owner receives. Like associates, owners' total employment costs shouldn't exceed 25 percent of their individual production. (To determine what those employment costs actually are, click here and download the Total Compensation Statement.)

So, for example, you might receive 18 percent of your production if you have substantial benefits such as health and dental insurance, a CE allowance, and your dues and licensing fees paid for. Or you may receive 24 percent with minimal noncash benefits. This allotment can vary among partners, which is in itself a benefit.

TIER 2 RETURN ON INVESTMENT

As an owner, you're entitled to a return on your investment. Your investment is the stock you own in your veterinary practice. To determine the value of your investment, you'll need to have your practice appraised by a veterinary-exclusive CPA. Don't try to perform this task yourself, or even ballpark it using an outdated method. In my experience, the rules of thumb used by owners to determine the value of their own practices (for example, the "value equals one year's gross" myth) are often completely inaccurate. Spend the money on a professional appraisal, then use that value to determine your return on investment income for the year. In subsequent years, you can calculate the change in value based on the percentage change in the gross revenue your practice achieves. Have a reappraisal performed every five years or so.

Let's say your practice's appraised value came in at $1 million. If you owned 50 percent of the stock, your stock value would be $500,000. In the Four Tier formula, owners normally earn a 9 percent to 12 percent return on investment. So if your return is set at 10 percent, you'd be paid $50,000 for the year ($500,000 × 0.10). In an S corporation, this return is usually paid monthly as a shareholder distribution—in this case, $4,166.66 a month. Naturally, this number is adjusted on an annual basis. S corporations declare the practice's value at an annual stockholders' meeting. (Yes, you're supposed to do this.)